That's why we call it 'work': subsidies as disincentives

Last week the Congressional Budget Office stirred up a hornet’s nest with its estimate of the impact of the Affordable Care Act on jobs. Here’s the key sentence: “CBO estimates that the ACA will reduce the total number of hours worked, on net, by about 1.5 percent to 2.0 percent during the period from 2017 to 2024, almost entirely because workers will choose to supply less labor—given the new taxes and other incentives they will face and the financial benefits some will receive.” The annual reduction was estimated to be a headline-grabbing 2.5 million jobs.

Critics of Obamacare greeted the news with barely disguised glee: “The CBO says that Obamacare is a job killer,” they crowed. That’s not what the CBO said, however: “The estimated reduction stems almost entirely from a net decline in the amount of labor that workers choose to supply, rather than from a net drop in businesses’ demand for labor.” The jobs aren’t eliminated; workers choose not to fill them.

The CBO identified two elements of the ACA that contribute to this finding. First, the law provides substantial health insurance subsidies to workers with low incomes. The goal is to reduce the number of people who are uninsured. But since we don’t offer the subsidies to everyone, they must decline as income rises. At a certain income level, the subsidy is gone and the worker has to pay the full cost. This gradual reduction in benefits has the effect of cutting the worker’s rate of pay. If working more adds 10 percent to your cash income, but you lose half that sum because the subsidy falls, then your effective raise is only 5 percent. We know that more pay spurs more work—and less pay spurs a smaller increase in hours worked.

The second part of CBO’s model observes that earners who aren’t getting the subsidy will likely face higher taxes. The subsidies aren’t free—higher taxes are a necessary part of the package. Once again, higher taxes on income discourage work. Again, the CBO: “If subsidies are not phased out or eliminated with rising income, then the increase in taxes required to finance the subsidies would be much larger.” And hours worked would decline.

A policy that reduces hours worked shrinks the economy’s capacity. A smaller labor force—fewer labor hours—means that less work can be done overall, thus lowering potential national income. Again, the reduction in hours is voluntary: The CBO is predicting that some workers will, on the margin, prefer the subsidy to more cash income.

The only surprise here is that so many find it surprising.

Most of us work because we get paid to do so. That’s why we call it “work.” If we cut wages, nearly all people respond by working less. A subsidy that is phased out as income rises has the same effect as a cut in wages: Net cash income from both working more and spending more on health insurance (because of the smaller subsidy) is less than the simple increase in wages. So we work less than we would have without the subsidy—paradoxical, but true.

The same principle applies to every benefit we offer to individuals with low incomes. Fewer seniors work today than they did before we established Social Security. Unemployment insurance enables people to remain unemployed longer—and they do. Cash assistance to mothers with children reduces work hours.

If our objective is to extract maximum work hours from the population, we’d eliminate every one of these programs. But we don’t out of compassion for the disadvantaged—recognizing, too, that we may need this assistance ourselves someday.

Economists have long toiled to design programs that reduce the disincentive to work. Some subsidies phase out only with a lag. Or we reduce the rate at which the subsidies decline. Or, as is the case with cash assistance provided through Temporary Assistance to Needy Families, we impose lifetime caps on benefits.

Compassion is messy. Each of us walks around with our own definition of need. With perfect knowledge of the circumstances of those we meet, we’d empty our wallets for some and close ’em tight for others. Without perfect knowledge and operating as a collective, we muddle along as well as we can. The Affordable Care Act extends our collective compassion to a new category of need. A reduction in hours worked is collateral damage to the economy.

Kent Gardner is chief economist and chief research officer of the Center for Governmental Research Inc.